I am always looking for an edge in the markets, and so it was with quite a bit of interest that I saw a divergence happening with the drooping gold prices recently, as represented by the GLD ETF, and the major gold equities as represented by the GDX ETF, actually going the opposite way and moving upwards. For material support, examine the following charts for the GLD and the GDX on May 4:
[Click all to enlarge]
The GLD, as indicated by the pink arrow, was swooning downwards on May 4.
The GDX, as indicated by the pink arrow, was recovering from the morning dip and then moved upwards in the afternoon, even while the GLD was moving downwards.
Pondering this odd divergence, I concluded that there is underlying strength in the precious metals markets and that buyers were positioning for the expected continual up moves in gold prices. Adding support to the fundamental strengths of the precious metals markets is the released news that the Mexican Central Bank purchased 100 tons of gold, in February and March, even while gold prices were breaching new highs. Therefore, obviously, the Mexican Central Bank believes that there is much room for precious metals prices to go higher.
The present markets are driving the gold and silver prices downwards, with Comex initiating an unprecedented four separate margin increases, the latest on May 4, for speculation on the futures markets.
Where will relief for the precious metals markets come from? I am a firm believer that the emerging middle classes of the Asian emerging markets will become the prime market drivers in the future. The main point here is that this Asian middle class is exploding in size and will be the prime factor for world markets in the future. Even presently, emerging markets are a strong driver as a consumer of rising metals and commodities prices.
To see what is happening in the emerging markets, I use the Shanghai Stock Market as a proxy for the Asian markets and have plotted the gold price together in the following chart, which shows a remarkable correlation:
Note that the rise in the gold price from summer of 2010 (marked by the pink rectangle) was preceded by a bottom in the Shanghai index trace. Also note that the recent February bottom for the gold price (marked by pink rectangle) was again preceded by a bottom in the Shanghai index trace. For both instances prior to the Shanghai trace bottoms (circled in green), as the index was declining, the gold prices were unsettled and were in consolidation.
Applying this knowledge to the current market for the gold prices (circled in green), we appear to be in a consolidation period, as the Shanghai index trace is again moving downwards.
Must we wait for a Shanghai index bottom before the gold prices move further up? To answer this question, let's examine the Shanghai index in the following chart:
The Shanghai index trace appears to be coalescing into a narrowing wedge triangle, as indicated by the burgundy lines outlining the dimensions. The two previous instances of the Shanghai index trace bouncing off the bottom of the triangle are marked in the green rectangles. These rectangles correspond roughly to the previous bottoms in gold prices. The present instance of the Shanghai index trace again hitting the bottom of the narrowing triangle boundary is marked with the third green rectangle. Will the Shanghai index now bounce, start moving up and take gold and precious metals prices with it?
The Shanghai stock market closed on May 2 for that nation's annual May 1 holidays. Even as the market is open this week, the majority of the Chinese population is enjoying a one-week holiday visiting family, to be back at work next week on May 9. In my opinion, this "Battle in Shanghai" of the index trace will result in a breakout to the high side and will lead gold prices higher still. I am preparing for the breakout and have invested in precious metals equities such as Goldcorp (GG) warrants.
Disclosure: Long Goldcorp and other precious metals equities.